What is arm’s length transaction ?
An arm’s length transaction is a transaction where a buyer and seller have equal bargaining powers about the price of the property, according to Redfin. In these types of transactions, buyers try to spend the least amount possible on the property whereas the buyers ask for the highest amount possible.
Through bargaining, buyers increase the prices and sellers reduce theirs. This process continues until both parties achieve the best price possible that benefits both sides.
In real estate, many home sellers price their properties at a much higher price than the values of their properties. Savvy homebuyers know this trick. This is why many homebuyers never offer the full asking price unless they are motivated buyers. Buyers start their offers at much lower prices in an effort to bring the property at fair market value.
There are some transactions that happen without bargaining. If the price is pre-determined and not negotiable; buyers must pay the full price or walk away.
Example of arm’s length transaction
Let’s say that you want to buy a house during a buyer’s market. The buyer’s market means that there is a lot of inventory than the demand for it. In other words, there are more houses for sale than buyers. This will give you bargaining power over the seller.
With this information in mind, you find a very nice property listed at $340,000. However, from your investigation together with your real estate agent, you know that the house’s true value is $290,000. The seller started much higher than the actual value of the house hoping to get more money from a novice or a very motivated buyer.
To save money on this property, your offer should start lower than $290,000, since this is the actual value of the property. You can offer $270,000 as your initial offer. This way you will have $20,000 to bargain with. If the seller is willing to negotiate, he/she will reduce the price while you increase yours. This process will continue until you come to a fair price. In this example, the fair price will be around $290,000.
Example of a transaction that is not an arm’s length transaction
Let’s assume that your daughter is turning 18 years and needs a car for college. Since you happen to have multiple cars, you decided to sell one to her. Due to the nature of your relationship, you will most likely sell it to her at a huge discount.
This transaction will not be an arm’s length transaction because the car was sold at a much lower price and there was no bargaining between the two parties. In other words, the transaction was more like an offer.
